Giving Up a Dream, Citadel's Founder to Sell Investment Bank

By AZAM AHMED and SUSANNE CRAIG

Published: August 12, 2011

It was to have been the summit of a spectacularly ambitious and rapid ascent in finance: turning what began as a $4.6 million hedge fund into an investment bank that could rival Goldman Sachs.

But three years and millions of dollars later, Kenneth C. Griffin is abandoning his quest. The founder of the investment powerhouse Citadel is now trying to sell Citadel's investment bank to focus on electronic trading in his securities division, a person close to the firm said.

In addition, the firm will shut down its equity research unit, said the person, who spoke on condition of anonymity because the information was private.

The moves represent a big setback for Mr. Griffin, just 42, who founded the hedge fund at age 22 after trading bonds from his dorm room at Harvard. In less than a decade he built Citadel into a $6 billion behemoth.

Still, the retreat did not come as a complete surprise: Citadel's investment banking business has been the subject of rumors for some time. Since 2008, the division has been a veritable revolving door of staff, with Wall Street bankers and executives departing Citadel with regularity.

''I can't think of one large investment banking deal they advised, or a new I.P.O. they brought to market,'' said Dushyant Shahrawat, senior research director at TowerGroup. ''So why stay in that business? It's a wise decision to shut down the operation rather than waiting another six months for the other shoe to drop.''

Indeed, Citadel Securities has advised on just four deals since 2009, and performed underwriting work on just 12 occasions, according to data from Thomson Reuters.

Mr. Griffin's failed banking expansion follows other stumbles. In late 2007 Citadel injected $1.75 billion into E*Trade, throwing a lifeline to the online brokerage firm, which was weighed down by millions of dollars in mortgage investments. In return for the investment, Citadel received a nearly 20 percent stake in E*Trade.

But E*Trade shares, which were near $46 in 2008 when he made the deal, now trade just under $12.

The investment has been a source of public embarrassment for Mr. Griffin, who has clashed with senior management at the online broker. In July he sent a letter to E*Trade saying the directors had ''squandered'' the firm's franchise through a series of bad decisions. E*Trade has hired Goldman Sachs to advise on its options.

Mr. Griffin's venture into investment banking began in 2008, about a year after his E*Trade investment and on the heels of the financial crisis when firms like Morgan Stanley and Goldman were struggling.

Known as intense, Mr. Griffin saw opportunity, and his push into investment banking was heralded at the time as getting in at a market bottom. He already had a reputation for sniffing out potential amid misery. The day after Enron's collapse, Mr. Griffin began recruiting energy traders for a new business. Eventually, he brought together a team of traders, meteorologists and researchers to run one of the biggest energy trading shops in the industry.

During the financial crisis, other investors made similar moves. The British investor Joseph Lewis lost hundreds of millions of dollars on a 2007 investment in Bear Stearns, which was sold to JPMorgan Chase for a fire-sale price. A number of sovereign wealth funds bought up shares of Wall Street banks - investments that soon soured.

For a time in 2008, Citadel itself looked as though it may not survive, sustaining losses of 50 percent. Nonetheless, figuring that he could compete on customer service and cost, Mr. Griffin went on a hiring binge, plucking top talent from Wall Street banks to staff the investment banking business.

But by 2009, Wall Street banks had recovered and were reclaiming their market share against upstarts like Citadel. And Mr. Griffin, known for his incendiary temper and aggressive personality, struggled to stem turnover at his shop.

Investment banking was not the only effort by Citadel to broaden its line of financial businesses, making it more like a Wall Street firm than a hedge fund. Mr. Griffin founded Citadel Securities in 2001. The division became a major player in the options market. And in 2006, Citadel raised $500 million in debt, an extraordinary measure for a hedge fund, and started a business offering administration services to outside hedge funds, which it recently sold off.

But the business of investment banking is very different from that of trading, analysts noted, requiring different skill sets that don't often complement one another. Trading is founded in emotionless market decisions executed in real time. The other feeds off relationships, sometimes cultivated over years.

Problems began to emerge at the banking business almost as soon as it began. In October 2008, Mr. Griffin brought in Rohit D'Souza, a former top executive at Merrill Lynch, to run Citadel Securities. A year later, he left. His replacement, Patrik L. Edsparr, a former JPMorgan Chase executive, stuck around for just seven months before he too departed.

The churn underscored the difficulty of breaking into the banking industry. While some new entrants, like Moelis & Company and Perella Weinberg Partners, have found success, Citadel struggled to gain footing in the advisory business.

Ultimately, investment banking made up just a fraction of the revenue of Citadel Securities. The bulk of revenue for Citadel Securities came from the market-making operation, one of the largest in the industry. Citadel executes 8 percent of all trading in United States stocks and 30 percent of all United States options trading.

Mr. Griffin had known almost nothing but success from the beginning of his career. With practically no formal training or work experience, he quickly captivated the world of high-flying hedge fund investors with wondrous returns. He founded his fund in 1990 with capital from just a few investors - his grandmother among them - and posted gains of 43 percent in 1991 and 40 percent the next year.

Before the financial crisis, his only down year was 1994, when the convertible bond market tanked and Mr. Griffin lost 4.3 percent.

Since the crisis, however, his funds have posted gains that have consistently beat hedge fund benchmarks, though not enough to surpass the losses sustained in 2008. That means that Mr. Griffin has yet to collect the coveted incentive fees that make hedge funds so lucrative.

An added focus on its hedge funds has helped this year. While many funds are suffering double-digit losses, Citadel, now a $11 billion behemoth, was up 14 percent as of last week, the person close to the firm said.

This is a more complete version of the story than the one that appeared in print.